ECONOMIC INDIVIDUAL ASSIGNMENT

ECN 341Comparative Economic Systems

Demitria Perera 1509

Asses the theoretical economic foundation of both Monitory and Fiscal Policy in a country.
What is there role(s) of them in building up the economic system? How they are operation
and what are the main objectives of these polices?
Introduction:
We can see that in the market economies there is a regular fluctuation in the level of
activities related to economy. In the market economy or in other words the market sector the
government consists of two forms of economic policies to control aggregate demand. There two
types of policies are namely monetary policy and fiscal policy. For instance when these two
policies are utilized to stimulate the economy during a period of recession, it is seen as the
government is pursuing expansionary economic policies. In the same way when the two policies
are used to contract the economy in a period of immense expansion, it is seen as the government is
pursuing contractionary economic policies.

What is Monetary Policy?

The monetary policy is a part of the general economic policy of the government. The term
monetary policy refers to the management of money supply and interest rates by Federal Reserve
System (central banks) to affect monetary magnitudes and other financial conditions (influence
prices and employment). The monetary policy operates on monetary variables that are interest
rates, money supply and availability of credit. It influences the expenditure flows in the economy,
which in other words can be describes as it affects the liquidity. Therefore as a result of affecting
liquidity and credit this has an effect on the total demand in the economy. When in time of
recession the monetary policy uses some monetary tools which thereby increase the money supple
and lower the levels of interest rates and stimulate demand in the economy. At the time of inflation
the policy tries to contract the spending by contracting the money supple or in other increasing the
rate of return. The decisions are made by the Federal Open Market Committee which meets every
six to seven weeks and the policy changes are possibly done immediately. The federal government
uses this policy mainly, but a conflict is that the Federal is independent of the President or
congress. This can be seen as an advantage when compared with the fiscal policy. The monetary
policy which works in expansion is commonly called “easy money” and contraction is on the other
hand called “tight money”.
A good example of monetary policy can be studied by looking into the United Kingdom.
The current monetary policy framework was introduced in 1997 and according to the “Bank of
England Act of 1998”. The monetary policy in UK is set by the Banks Monetary Policy Committee
(MPC). They do this by the Bank of England studying the inflation trends in the economy. They
look into variables such as Unemployment, consumer confidence, Spare capacity in the economy,
Exchange rate index, House prices and Economic Growth. Their main objectives of this policy are
to make sure of economic stability of full employment or output levels, the controlling of inflation
and deflation to ensure price stability and to bring about growth in the economy. The tools which
are used for monetary policy are Bank rate policy, open market operations and changing Cash
Reserve Ratio.
If the Bank of England (BOE) identifies inflation as dropping below the target of 2% the
government or the economy is heading towards recession then the act is likely to be as cutting
down interest rates. In the same way if the economy is growing too quickly they increase the
interest rates.

At the same time there are limitations to monetary policy:

• Liquidity Trap

• Difficulty to control many objectives with one tool like for example in a case where an
increase in oil prices causes cost push inflation and lower growth. The Bank could raise
interest rates to decrease inflation, but, it would cause economic growth to decline as well.

• Changing interest rates has an effect on the exchange rate

• Interest rates may affect some parts of the economy more than others

What is Fiscal policy?

The national government’s responsibility is to prepare budgeting and financial strategy for
the country. In economics this can be defined as the use of national government expenditure,
revenues and borrowings to influence the way of the economy. In other words this can be describes
as government changing the levels of taxation and government spending to influence aggregate
demand. The goal is basically to enhance the economy’s health and growth. For example let’s say
that the economy growth has slowed down and the unemployment rate is high, businesses are not
creating wealth and the consumers are spending less. The government will decide to direct the
economy by bringing down taxes, providing consumers with more money at the same time
increasing the government’s spending in the form of buying services.

Fiscal policy is carried out by the executive and legislative branches’ of the government. Fiscal
policy can be better studied by looking at Australia. For the past few years the fiscal policy
framework and outcomes have evolved significantly in the past quarter century in Australia. For the
last few decades the policy makers have focused on forming a medium term fiscal framework to
make policy decisions. The government has focused on achieving the following 3 objectives which
are achieving internal balance, external balance and the growth of the economy. The fiscal policy
has played a key role in the policy mix. The government has used the policy to improve Australia’s
national savings and the control of government public debt with the aim to keep the external factors
in control and economic stability.
 Two important medium-term influences on fiscal outcomes

– Large current account deficits (CADs) since mid 1980s

– Ageing and rising projected public cost of health care (relevant more recently, and

increasingly so)

The Australia fiscal policy has experienced different phases over the past few decades. The private

sector investment decisions and saving are now better, and the government has recognized

Australia’s position to be a capital importing nation with more foreign investor’s resulting capital

surplus. The objectives have been to achieve desirable income distribution, achieve desirable

employment level, achieve desirable price level, and achieve desirable consumption level, degree

of inflation and to increase in capital formation. Due to the two important medium term influences

on fiscal the framework had evolved. The government achieved strong fiscal outcomes and the

resulting total of budget surplus accounted $40 billion. They said that in order to manage a

substantial resource boom the fiscal policy needs to be tightened wherever possible to boost

national savings. According to latest reports 2010-11 budget expenditures will prioritize returning

Australia to full capacity utilization, climate change and tackling the fiscal pressures of an aging

population. The fiscal policy deals with government policy that attempts to direct the economy

fiscal allowances.

Conclusion

In monetary policy the federal government uses this policy mainly, but a conflict is that the

Federal is independent of the President or congress. This can be seen as an advantage when

compared with the fiscal policy. Monetary policy is maintained by the central bank whereas the

fiscal policy is managed by the government. The Monetary policy is commonly used. However,

monetary policy has its limitations. In serious recessions, we invariably need a combination of the

two policies.
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References

http://www.ehow.com/about_6403056_fiscal-monetary-policy.html

http://www.treasury.gov.au/documents/1239/HTML/docshell.asp?URL=02_Part_1.htm

http://en.wikipedia.org/wiki/Monetary_policy

http://www.mortgageguideuk.co.uk/finance/monetary_policy_uk.html

http://everydayecon.wordpress.com/2010/10/27/monetary-policy-in-the-u-k/
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